The crisis in Greece and the Eurozone has escalated as depositors flee banks in fear not only of the consequences of sovereign default but also of Greece abandoning the Euro. Unfortunately, this development makes the crisis much deeper and more difficult to manage. As we (along with Eduardo Levy Yeyati) highlighted in a VoxEU piece in June 2011, the main risk of the Greek debt crisis was its potential spillover to the banking sector. The experience of emerging economies is very telling in this respect, where sovereign debt, currency, and banking crises have been historically highly intertwined. These connections seem new to policymakers in developed countries who, until now, appeared to have undermined the dangers associated with rising levels of sovereign and currency risks. The following is an excerpt from the VoxEU piece "Triplet crises and the ghost of the new drachma."
"Much of the discussion surrounding the Greek crisis revolves around the probability and implications of a sovereign default and on whether the introduction of a national currency (which, for simplicity, we could call the new drachma) would help pull the Greek economy out of recession (see for example Manasse 2011 on this site). Less attention has been paid to the banking sector, which often plays a decisive role in the development of debt and currency crises.
- What would happen to local banks if, as expected, the threat of default or even exit from the euro lingers?
- Can a bank run precipitate an involuntary resolution of the crisis before Eurozone members agree on a deliberate one?"
Read the full post here.